Prospect Theory

This was a bunch of lecture notes I made before a quick talk explaining the basics of prospect theory to the Madison Less Wrong meetup. I haven’t even tried to make this readable, yet.

The Allais Paradox

From WP:

Gamble 1:

Option A: Gain $1M.

Option B: Gain $1M at 89% or gain $5M at 10%.

Gamble 2:

Option A: Gain $1M at 11%.

Option B: Gaim $5M at 10%.

Alternately, from LW:

Gamble 1:

Option A: $24K at 100%

Option B: $27K at 33/34

Gamble 2:

Option A: $24K at 34%

Option B: $27K at 33%

The Endowment Effect:

“Pure tokens”, tradeable for between $10 and $20 dollars at the experiment’s end: markets worked.

Mugs: Some of the group (Sellers) are given a nice mug (worth about $6), Buyers had to use their own money to by mugs if they wanted them. Average selling price was about double the average buying price. Later, “Choosers” could accept either a mug or money, at whatever point they found themselves indifferent.

Averages:
Sellers: $7.12, Choosers: $3.12, Buyers: $2.87.

Prospect Theory: Evaluation

Values of gains or losses. (losses about double slope of gains; range between 1.5 and 2.5)